How to determine what piece of paper will really pay off

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Oct. 17, 2003 — With college tuitions heading toward the stratosphere this year, you might well be wondering whether a degree is still a good investment, especially if you’re facing the prospect of going into debt to pay the tab.

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And if, as we all know, some bachelor’s and master’s degrees are much more lucrative than others, which are the best investments? To find out, I sat down with my handy-dandy financial calculator to play with some numbers.

It would be an impressive understatement, by the way, to call these figures a rough estimate. I had to make too many assumptions and leave out too many factors for these numbers to be anything other than a parlor game for those who might be interested.

But what they told me supported both common sense and what I’ve observed in the employment marketplace. For example:

Associate’s degrees are a slam dunk. These two-year degrees seem to result in a massive payback, compared to their relatively low cost, for a high school graduate.

Ditto, usually, a bachelor’s degree. Any bachelor’s degree you get at a public university is likely to pay off handsomely, as well. If you’re attending a private college, though, you might want to steer clear of education degrees.

Some degrees are a step back. Thinking of a master’s degree in a liberal arts or social sciences field? Let’s hope you’re in it for the love of learning, because on average there doesn’t seem to be any financial payoff.

Professional degrees rule. There’s a reason why people borrow tons of money to attend law and medical schools. The return for a professional degree is huge.

The calculations
I started with a set of Census Bureau figures — average pay rates for specific degrees, last collected in 1996. As a proxy for real lifetime earnings, it’s not perfect, but it does reflect the wide range of pay scales for each degree, from those just starting out to those ready for retirement.

What I was looking for was the “present value” of the increase in future income that could be expected with various educations. A dollar paid in the future is worth less than a dollar today, but it does have value. Compute the values of all those future dollars and you get a lump-sum figure that can be compared with the cost of an education to see whether the investment in tuition was worthwhile.

Professional investors do these calculations all the time to determine whether to put their money on the line. It’s also the process used to determine the payout amount when a lottery winner opts for a lump sum rather than 20 or more years of annual payments.

Normally, a net-present-value calculation would subtract the upfront investment cost. Since education costs can vary so widely, I’m presenting the numbers without that subtraction. You can do your own math, depending on how much you think your education will set you back.

Milage may varyThe College Board tells us that four years’ worth of tuition, fees, books and supplies at a public university currently cost about $20,000, while the private version will set you back $80,000. Add in room, board, transportation and other costs, and the total tab spirals to about $50,000 for public schools and $110,000 for private.

Your mileage may vary, of course:

People often don’t pay the “rack rate” for college; most get discounts of some kind, typically in the form of financial aid.

At the same time, loans taken out to pay for school will increase the cost, since you have to pay them back with interest. The higher the rate, the bigger the cost: A $20,000 loan at 8 percent will cost nearly $30,000 to pay back over 10 years.

You typically can’t know in advance how much interest you’ll pay, since rates on student loans are set after you graduate, and your payments commence.

Big bang for associate degree
Now that you know all that, here’s what I came up with (using a “discount rate” of 5 percent for you detail bugs who care) for the increase in lifetime income from a two-year degree:

As you can see, the average increase in income from an associate degree, compared to what a high-school graduate would get, is about $116,550 today. Subtract the average cost of tuition and books at a two-year school — about $2,500 — and you’re way, way ahead. AA degrees in engineering and computers have the biggest payoff.

Engineering and computers are once again the big money-makers, although the business degree has a higher-than-average present value. The only squeaker here is the education degree, which makes sense. If you’re going to teach in a public school, you probably don’t want to blow $110,000 on an Ivy League education if financial calculations are your motivating factor.

How Master's diplomas pay off
The remaining tables show the present value of the increase in income compared to a bachelor’s degree holder:

You’ll notice two of the degrees have a present value of less than zero.

How can this be?

Well, the Census Bureau’s figures show that someone with a liberal arts master’s degree earned just $5 a month more, on average, than someone with a bachelor’s in the same field ($3,460 compared to $3,455).

In fact, the average liberal arts M.A. earned about $300 a month less than the average bachelor’s degree recipient.

Social science master’s degrees were slightly more lucrative, but still earned less than the average bachelor’s.

Professionals and their huge loans
Does this mean you should never pursue a master’s degree in English or an advanced social studies degree? Of course not. But I wouldn’t go up to your ears in hock to pay for it.

Speaking of hock, huge student loan debts are often the price of a law or medical degree. The good news is that it seems to pay off. The $100,000 or more you borrowed for med school pales next to the $1 million present value of the payoff.

Unfortunately, the bureau’s sampling was too thin in the Ph.D. stratosphere to tell us much about payoffs other than the doctoral science degree is more valuable than the average Ph.D. But you really didn’t need me to tell you that.

You also don’t need me to tell you that averages aren’t predictive for the individual. You may earn way more or way less in your chosen field, depending on your initiative, the breaks you get and labor supply and demand throughout your working life, among many, many other factors.

You’ll probably be happiest, though, if you don’t dig yourself deeply in debt for a field that traditionally doesn’t pay well. Make sure the size of your investment, in time and money, bears some relation to your eventual reward.